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Fiducian Economic August 2023 commentary

The global economy has continued to slow in response to severe measures taken by most of the world’s major central banks, especially across the advanced economies, to counter rising inflationary pressures. As the International Monetary Fund (IMF) noted in its July report, ‘inflation is easing in most countries but remains high, with divergences across economies’, while ‘core inflation has on average declined more gradually and remains well above most central banks’ targets’. While highly expansionary monetary policy, combined with enormous government spending programs designed to sustain employment during the pandemic, were the factors driving inflation upwards, it is taking time to bring inflation back down to target levels. The task has only been made more difficult by fiscal policy (government spending) remaining relatively loose in many jurisdictions. Central banks are trying to achieve ‘soft landings’ by bringing down inflation while avoiding recession; but some economies are already in or close to recession, notably Germany, the Euro zone as a whole and the UK. In this environment, unemployment has begun to edge up and, in time, this will reduce wages pressure and thus inflation. As such, interest rates could be close to peaking.

In the case of the US, the ‘Fed’ raised rates again on 25 July to a minimum of 5.25% and, on 25 August, ‘Fed’ Chairman, Jerome Powell, stated that ‘recent readings on consumer spending have been especially robust and additional evidence of persistently above-trend growth could warrant further tightening of monetary policy’. Nevertheless, it is likely that interest rates are near a peak, especially as ‘headline’ inflation had dropped to 3.3% as of July this year, although ‘core’ inflation remained higher at 4.3%. In Europe too, inflation remains stubbornly high. Overall, tightening has slowed economic growth and the IMF is now forecasting global growth of 3.0% this year and only 1.5% for the advanced economies, with ‘risks tilted to the downside’.

The Australian economy slowed during the March quarter, expanding by only 0.2% and on a per capita basis it actually contracted (by 0.2%), indicating that the country could already be in a per capita recession, with output also likely to be weak in the June quarter. A key factor driving this slowdown has been rate rises by the Reserve Bank, which have been weighing on household spending, with household discretionary spending falling 1.0% over the quarter. Inflation has slowed but unemployment may need to rise further.

Most share markets began to slide in early 2022 in response to signs of rising inflation but there has been some recovery in markets since late last year. This year, up to 29 August, market movements have included rises of 17% for the broad US market (S&P500), 33% for the technology-focused Nasdaq, 14% for Germany, France 14%, the UK 1%, Japan 24%, China 2%, India 7% and Australia 4%. The US market appears fully valued but most others appear fairly valued, assuming that interest rates soon stabilise.

Major sovereign bond markets saw yields reach record lows in March 2020 as central banks sought to push rates down to lift economic activity in response to the outbreak of the pandemic. However, sovereign bond yields trended up through 2022 and 2023, as economies re-opened. The US 10-year Treasury bond yield fell to an historic low of 0.54% on 9 March 2020 but was 4.12% on 29 August this year. Similarly, the Australian 10-year bond yield was 0.57% on 8 March 2020 but was 4.10% on 29 August 2023. Some bond markets could experience lower yields this year if growth softens significantly.

Fiducian’s diversified funds are currently around benchmark for international shares, domestic shares and listed property. Exposure to fixed interest sectors has been lifted to close to benchmark, while cash holdings have been lowered to around benchmark.

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Lindale Insurances Pty Ltd ATF Lindale Insurances Trust ABN 27 027 421 832 is a Franchisee of Fiducian Financial Services Pty Ltd, Level 4, 1 York Street, Sydney NSW 2000. AFSL 231103 ABN 46 094 765 134.

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